Proof (Using 24+ Years Data) that Market Timing May Not Be Worth the Effort…Atleast for Us

I know people who have an uncanny knack of making correct calls (with almost perfect timings) in markets. And surprisingly, they are right more often than they are wrong. This surprises me as almost all wise investors are of view that average investors should not try to time the markets. Maybe I am wrong in putting these people in category of average investors. 🙂

Jokes apart, I feel that making correct calls and making money in markets are two very different things. And as far as timing is concerned, I think that timing the markets is very tough, if not impossible. And as an extension to this thought, I feel that accepting one’s inability to time the markets can eventually help amass quite a lot of money in markets.

I keep looking for data which proves the futility of market timing, atleast for average investors. This post evaluates data set for last few decades to see whether it makes sense to try to time the markets or not.

Now someone has rightly said:

“The market timer’s Hall of Fame is an empty room.”

Even Peter Lynch, one of the greatest investors of his generation, who also popularized the concept of PEG Ratio once remarked:

 “I can’t recall ever once having seen the name a market timer on Forbes’ Annual List of Richest People.”

Now to evaluate the usefulness (or uselessness) of market timing, lets pick 3 long term investors named A, B and C.

Investor Types

All three investors invest Rs 5,000 every month. Only difference is the timing of their investments.

Investor A invests on Monthly Highs (Perfect Mistiming)
Investor B invests on Monthly Lows (Perfect Timing)
Investor C invests on any one of the trading days of the month (Average Timing)
Now performance of these three investors has been evaluated over 5 different time periods (with amounts invested in brackets):

Starting 1990 – 24 Years Till Now (Rs 14.8 Lacs)
Starting 1995 – 19 Years Till Now (Rs 11.8 Lacs)
Starting 2000 – 14 Years till Now (Rs 8.8 Lacs)
Starting 2005 – 9 Years till Now (Rs 5.8 Lacs)
Starting 2010 – 4 Years Till Now (Rs 2.8 Lacs)

Results obtained by them over various time periods (upto 01 August 2014 – assuming complete month) are given in table below:
Market Timing Investor

Remember that Investor A is a Perfect Mis-timer and Investor B is a Perfect Timer. The calculations are based on actual Sensex figures between 1990 and 2014.

As you can see, the difference between a Perfect Timer (Investor B) and a Perfect Mis-timer (Investor A) is not as big as expected. For example, if both started out in 1995, their total investment of Rs 11.8 Lacs would have become Rs 54 Lacs and Rs 49 Lacs respectively.

A figure of Rs 49 Lacs is not bad for someone who got it wrong each month of the year since 1995!! He invested when index was at its highest point of the month. And he still fares decently when compared with Rs 54 Lacs achieved by a perfect timer (Investor B).

As an investor, I know I cannot time the markets perfectly, i.e. I am not Investor B. But since I invest regularly, I also know that by principle of averages, I cannot be Investor A, i.e. I cannot possibly pick the highest point every month to invest. This leaves me with just one option…that of being Investor C.

And I will be glad to be like Investor C.

Reason?

Without the effort (like that required by perfect timer), I am able to earn returns which are respectable when compared to those earned by a perfect timer. And this is clearly visible in table below:

Market Timing Outperformance

There is no big outperformance achieved by the investor who times the market perfectly (atleast monthly). As an investor who strongly believes in Power of Doing Nothing in Stock Markets, this result should be acceptable to all average investors.

And this clearly (if not convincingly) shows that if someone is ready to invest periodically with discipline, then timing the markets may not be essential at all. I agree that I have made few assumptions in these calculations. And that these may not be a technically correct ones when trying to prove the uselessness of market timing. But for average investors like us, this analysis is a clear indicator that if one is not interested questions like how and which stocks to pick, then trying to time the markets may not only be futile but also a worthless exercise. 

Just keep investing regularly in well diversified equity funds or index funds. You will be better off than 99% of the investors.

Caution: The data used in above tables is only for one index (Sensex) and hence representative of performance of a weighted-combination of only 30 companies which constitute the index. And since index constituents change over time (existing companies are regularly replaced by other ones), its possible that numbers might differ if any other index is chosen. Also, as a reader has rightly pointed out in comments below,  if the same logic is used for a combination of companies which are not part of the index, chances are that you might lose some money! But this also does not mean that if you follow passive investing, then you will not lose money. In markets, no matter how careful we are, we can never eliminate the risk of being wrong. 

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One of the Biggest Reasons You should be Investing. Even if you can’t beat the Markets.

Surprised?

I am asking you to invest, knowing very well that most of you may not be capable of beating the markets regularly.

Let’s be honest here. Most investors haven’t been able to beat markets consistently over long periods. I am not talking about greats like Buffett. I am talking about common people like You and me. People who have an intention of making a killing in markets, but somehow or the other, end being killed by the markets.

But if you know that you cannot beat the market, then does it make any sense to be in market?

Yes it does.

But first and foremost, please understand that accepting and embracing the fact that you are incapable of beating markets is an achievement in itself. 95 out 100 people in markets do not know this or don’t want to accept this. But it is the hard truth and tough to swallow.

But…if you are ready to accept this uncomfortable truth, then it can be one of your biggest strengths in stock markets. 

Market has an unbelievable potential of creating wealth. On an average, markets deliver annual returns of 12% to 15% over long term.

For someone who is capable of beating these numbers, returns would be in excess of 15%. But for those who are not in markets, all they can possibly earn is 7% to 9% depending on taxes applicable on the chosen asset class like banks deposits, etc. By not investing in markets, these people are missing out on extra 3% to 5% which can be earned by staying in markets.

Now these might look like small single-digit numbers. But you will be shocked to see the effect these numbers have on your wealth over a period of 10-20 years.

And the graph below clearly shows this. It’s a very simple depiction of what happens when an annual investment of Rs 60,000 (5K Per month) grows at 12%-15% (Equities); and what happens when the same money is parked in safer options at 7%-9% (FDs, PFs, etc).
Monthly Investment 20 Years
Returns on Rs 5000 per month investment in 20 years (At 7%, 9%, 12% and 15%)
Over a period of 20 years, you would have put in Rs 12 Lacs, i.e. Rs 5000 every month. Now this can either grow into Rs 26 to 34 Lacs if invested at 7% to 9% class of assets. Or into a much bigger amount of Rs 48 to 71 Lacs if invested at 12%-15% in stock markets.

Now wait…if you think that markets guarantee 12%-15% every year, then that is not the case. Returns in market are volatile. It can be 50% in one year and (-)30% in another. But over long periods spanning decades, the average returns are in line with these numbers.

And this clearly means one thing…

Even if you cannot beat the market, you should still not avoid investing in it.

Avoiding markets would prevent you from achieving higher long-term returns when compared with other options like bank deposits, PF, etc.

So is there a way to invest in markets, which is…

1) Simple
2) Sensible
3) In line with the thought that it is not easy to beat markets?

The answer is yes.

And the way to do it is Index Funds.

What is an Index Fund?

According to Investopedia, Index Fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index (such as Sensex or Nifty 50). An index fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.

You might not know which individual stock or sector will outperform. But on an average, a carefully selected group of companies across sectors can do a decent job of maximizing diversification and minimizing exposure to few individual companies or sectors.

I am not saying that you should invest all your money in index funds. But if you think you want to save (invest) for long term, then atleast a part of your money should be parked in instruments linked to stock markets. And your safest bet can be Index funds. You can also choose well diversified large-cap or multi-cap funds which have proven track records. But that would mean that returns achieved by such funds would depend on fund manager’s ability to pick stocks. On the other hand, there is no active selection of stocks in index funds. Such funds simply replicate the composition of an index.

So if you feel that you have a knack of picking stocks which give market beating returns, then there is nothing like it and you should surely invest in stock markets directly.

But if not, then may be its time to think a little more seriously about Index Funds. And that is because if you are not in markets, then over long periods, you are missing out on some seriously big wealth creation opportunity.

Interesting Story:

When Google was about to launch it IPO in 2004, the company realized that this would create quite a few millionaires among its employees. The company therefore brought in a series of financial experts to teach them to make smart investment choices. A 1990 Economics Nobel Prize winner was also brought in. Even he advised Google employees “[not to] try to beat the markets” and to park their money in index funds.

Seems like Someone has rightly said – If you can’t beat them, join them. 🙂

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Mailbag: I am 45 years old & want to accumulate shares of good companies for next 20 years

A reader aged 45 had the following query. Though he asked the question on Stable Investor’s Facebook page, I thought it would be a good idea to share it with loyal website readers to know their views.
 
 
 
So here is his question:
 
“I am 45 years old and wish to invest in equities for long term. My goal is to create a corpus, which I may use when I’ll cross 65. Hence in which Indian companies should I invest? I plan to buy stocks of the chosen companies regularly in small quantities in “buy-and-forget” mode. I don’t want to be bothered about daily price fluctuations or viability of company’s business. Please recommend a few companies which you think would keep performing well for years to come. I assume that at whatever price I buy these stocks, I would eventually have significant capital appreciation over the next 20 years.”
 
Now this is what I think:
 
I am assuming that you are adequately insured and have sufficient money in your emergency funds. With this assumption, I would say that it is always advisable that one should invest in multiple asset classes, so that there is no concentration risk. I am assuming that since you plan to invest in the so-call-risky asset class, you already have decent positions in less risky ones like PPF, PFs, NSCs, bonds, FDs & RDs etc.
 
Now Buy and Forget kind of investing requires that you pick companies which you are sure are going to survive for next 20 years. These are companies which essentially, have a greater ability to suffer than other listed companies.
 
Once you have taken care of survival, you need to shortlist those which have a good probability of flourishing in next 20 years. Just these 2 filters would reduce the list of probable companies to less than 10-15. And that in itself is a pretty manageable number.
But having said that, I would digress a little from this topic of direct equity investment. You can, or rather should consider routing a substantial part of your planned monthly investments through index funds. You might argue that investing in index funds would eliminate the probability of picking up multibaggers, even when considering a 20 year time frame. That’s correct. But this would also eliminate the possibility of ending up with stocks of companies which might be very close to being shut down at end of 18-19 years of your stock accumulation period.
 
Now no one would want to accumulate shares of a company for 19 years, only to find that when he requires that money in 20thyear, share prices have crashed down and business is about to close. 🙁 So, I would suggest that you should give index fund investing a serious thought.
 
Sometime back, I had suggested a similar approach to two young readers who also intended to invest for next few decades! You can read those discussions here and hereBut if you still want to go ahead with a Direct-Equity-SIP sort of a program where you buy few shares of companies every month for next 20 years, you should stick to companies which pass the following criteria –
 
First
 
Provide products and services which would have increased demand in years to come and are ideally placed to benefit from India’s demographic profile over next 20 years.
 
Second
 
To meet this demand, these companies should depend as little as possible on debt and should be able to fund their expansion through cash flows itself.
 
Third
 
The companies should be run by trustworthy and proven management. You don’t want to handover your hard earned money to companies which are not run by people whom you would personally not like to interact with. Isn’t it?
 
Fourth
 
Personally speaking, dividend paying companies ring a bell for me. But you can choose not to consider this criteria.
 
So once you have shortlisted companies according to these criterias, you would have very few companies which you would like to invest for next 20 years.
 
One such company which comes to mind is ITC. You can create your own list of such companies.
 
It is always better to have a framework (structure) before you go ahead picking specific stocks. Hopefully, this post will help you in coming up with a correct framework to pick stocks worthy of long term investments.
 
This is what I feel should be done by the reader. What do you all think?
 

Building a portfolio for lazy investors

Nature’s depiction of a Lazy Investor

Not everyone has time or energy to invest in stock markets. Some have the money to invest. But everyone wants to make money in stock markets 😉 It is like saying that one wants to go to heaven but doesn’t want to die. We have already shared our thoughts on how doing nothing can work in stock markets. This post continues on building on magic of laziness.

 
Who should be interested in creating a Lazy & Boring Portfolio?
 
Anyone who has neither time nor energy to invest in stock markets but would like to atleast match the returns offered by overall markets. Though you can afford to not have time and energy, when investing in stock markets, you cannot afford to not have money. 🙂 But beware…you should take care of 3 very important things before you even think of investing in stock markets.
 
How to create a Lazy & Boring Portfolio?
 
We suggest following action plan for creating this portfolio –
  1. Start investing regularly and equally in 2-3 Index Funds. We recommend you read about importance of Index Funds to fully understand their benefits. After that, you can look at a list of Index Funds in India to choose the funds you want to invest in.
  2. India is a growing economy and is expected to maintain high growth rates for atleast a decade or two. So it’s not advisable to stay away from actively managed mutual funds. Alongwith index funds, one should also invest in about 3 Equity Funds – Large Cap, Mid Cap & Multi Cap Funds. This would provide adequate exposure to growth stories at various market capitalization levels.
  3. We assume here that one would also be interested in picking direct stocks. For boring and lazy investors, we suggest they stick with stocks of good companies. But good companies are not good investments at all prices. Hence one should wait to buy direct equities when markets are undervalued. Overall market undervaluation can be judged by checking ratios like P/E, P/B Ratios and Dividend Yields of the market. Our take is that markets trading at anything below P/E of 15-16 can be considered to be a good time to enter individual stocks (assuming that stocks themselves are not overvalued compare to their industry peers or due to some news or irrational exuberance). Having addressed the issue of when to buy, we now face the question of what to buy. A good starting point can be stocks making the index (like Nifty 50 or Sensex). These are large cap stocks that can be considered to be good long term picks. Another good but boring idea can be to look at stocks that pay good dividends and have good dividend payout history. These stocks offer constant stream of increasing cash as dividend payouts.
  4. Till now we have only looked at direct and indirect equities. It would be wise to have debt (funds) to bring in stability to the portfolio. Though Stable Investor has not done any research in domain of debt funds, a good starting point can be list of good long term debt funds available at moneycontrol.com
  5. Last but not the least, it is advisable to put some money in Bank fixed deposits too. You never know when you might get an opportunity to invest substantially in markets (Think: Crashes). During such times, FDs can be liquidated to enter markets and get stocks at bargain prices.
So what would be an adequate mix of all 5 above mentioned investment vehicles?
 
The right mix would depend on an individual investor’s risk appetite, laziness 😉 & investment time horizon. We suggest a below mix for an average investor…
 
 
A risk-averse investor may want to reduce exposure to index and equity funds from 60% to a lower figure of 20-30%. An enterprising investor with a long investment horizon may want to increase his exposure to equities and reduce that of Bond Funds & FDs from 30% to 10%.
 
Lazy investors (& not people) should understand that though they may not have a glamorous transaction record, maintaining their portfolio in line with their own personality will help in diversification, lowering of risk, leveling out of bull/bear cycles and generate market equaling returns, without having to stress yourself and missing out on more important things in life like family, friends and others 🙂

Power of doing nothing in stock markets – Indian Stock Markets Perspective

A study found that a goalkeeper who stands in the middle — the stock market equivalent of doing nothing — has better success than one who tries to guess which way a free kick will come. It was found that goalkeepers jumped to the left or the right significantly more than was useful in preventing goals. In fact, they jumped an overwhelming 94 percent of the time – meaning they stayed in the middle only 6 percent of the time. In comparison, the shot went towards the centre 29 percent of the time. Goalkeepers, it seems, could achieve more by doing less.

 
 
 
Similarly in managing stocks in your portfolio, it is often best to stay in the centre and do nothing. Sitting put on your index funds & dividend stocks, not trying to find the bottom & most importantly, not panicking, serves an investor better than trying to guess and time the markets.
 
Experts (though you should not believe them blindly) agree that investors will be better off resisting the temptation to make changes to their long-term investments simply because of short-term stock market movements. If your personal circumstances and financial goals haven’t changed, and you are still interested in being invested for the long term, then it is probably appropriate to ‘do nothing’.
 
To test the benefits of doing nothing in Indian markets, we analyzed the data for last 20 years. We specifically looked at 5 & 10 year rolling returns (CAGR) of Sensex (index) to understand whether it made sense to invest once and sit through years doing nothing?
The results are shown in graphs below –
 
Click to enlarge
Returns on rolling 5 Years
  • Average 5 years returns have been a good 11.8% pa. i.e. if you invested some money in index (Sensex in this case) and did nothing for next 5 years, your money would have grown at a rate of 11.8% every year (Doubling in just over 6 years).
Click to enalrge
Returns on rolling 10 Years
  • Average 10 years returns have been a good 10.9% pa. i.e. if you invested some money in index (Sensex in this case) and did nothing for next 10 years, your money would have grown at a rate of 10.9% every year (Doubling in just over 6.5 years).

Now these two figures of 11.8% & 10.9% are not earth shattering, but if maintained for decades, they have the potential to make investor following do-nothing approach, super rich.

 
Summarizing our finding in table (below), we found some interesting things –
 
  • In all we had 201 Five-Year Periods. Of these returns earned in excess of 10% were 91 of those periods. i.e. 45%
  • The buy and hold strategy (for 5 Years) beat long term average of 11.8% a good 37% of the time.
  • For Ten Year Periods, we had a fewer 141 periods. Returns earned in excess of the long term average of 10.9% were a brilliant 59% of the time. i.e. If you stayed invested for 10 years and did nothing, chances of beating the long term average were a high 59%.

And you thought that buying and holding did not work! 🙂

 
So does it mean that Doing-Nothing works? We would say that it does, but only if you are ready to follow it for long term. And long term means years (decades) and not months. Frankly, there doesn’t seem much point in overanalyzing, overthinking, and exhausting oneself by trading in the short term. We must understand that it is TIME and NOT TIMING that is the key to successful investing.

Nifty & Sensex Index Mutual Funds

After writing the last post on importance of index funds, we decided to compile a list of all index funds tracking Nifty & Sensex.


All data has been sourced from Moneycontroland it is found that GS Nifty Index Fund is by far the largest index fund, with an AUM of Rs 552+ crores.

Top 10 Index Funds (AUM) – Jun 2012
Generally, all index funds trail the index because they incur costs and keep some cash for redemptions.

Below is a list of all index funds tracking Nifty or Sensex. The list is sorted in descending order of AUM. It also includes funds which track other important indices like Nifty Junior etc. Such funds have been italicized in the list.

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200 Day Moving Averages (200DMA) Based Investments – 5 Years CAGR

In the previous post, I analyzed returns on investments based on 200DMA and how such investments performed over 3 year periods. This post is an extension of the thought with only change being the increase in evaluation period from 3 years to 5 years.
Just to remind everyone, 200DMA is calculated by taking the arithmetic mean of all values in consideration (Stock prices, index levels) in last 200 trading sessions (40 weeks). Before going forward, I would recommend that you get a basic understanding of how to calculate 200 Day Moving Average & how to calculate CAGR
You can easily find data for last 20 years on NSE’s or BSE’s website. Similar to that in previous post, a comparison of 5 years compounded annual growth rate (5Y-CAGR) was made against the index’s distance from 200DMA.
200 Day Moving Average Returns 5 Year
Correlation | Investing based on 200DMA & 5 Year Returns (CAGR)
The blue portion indicates index’s level (+/-) from its 200DMA. For example, in region marked P, index was trading at levels 20% lower than its 200DMA.
The red portion indicates returns over a 5 year period on CAGR basis.
A few interesting results that can be seen from the graph are –
  • In regions marked P, Q, R, S, & T, the index was trading 20% lower than its 200DMA. And as red graph in these regions indicates, returns have always been in positive territory.
Possible Deduction: Chances of your investments earning a positive return are more if you invest at times when index is trading at a discount of 20% or more to its 200DMA.

  • Region A (i.e. Year 2000-2004) is a possible outlier in this analysis. During this period, India was in long term secular bull market and as evident from the graph, relation between 5Y-CAGR and distance of index from its 200DMA is not evident. Returns continue to be positive even though Distance from 200DMA continuously switches between positive and negative territories.
This 5-Year analysis and a similar 3 year analysis done previously reveal that if an investor is ready to invest in markets trading at large discounts to their 200DMAs, probability of earning positive returns over long terms is quite high.

Though 200DMA is generally considered as a tool to be used by traders, it can very well be a potent tool in the hands of a long term investor who wants to time his entries in the market.

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